Tag Archives: shell status under Rule 144

Can a Start Up Go Public via S-1 as a Shell Company?

Filing an IPO via S-1 Registration Statement gives any private US corporation the opportunity to go public on the OTC Bulletin Board or OTC Markets.   Contrary to popular belief, the SEC does not require companies going public to exceed any minimum asset or revenue criteria.  Any US domiciled corporation can go public using Form S-1 even if it is a brand-new start up with very few assets and zero revenue.

The Decision to Declare Shell Company Status in an S-1

If a start up company’s S-1 Registration Statement shows few assets and operations, the SEC staff member reviewing the S-1 may request that the start up either declare itself to be a shell company as defined in Securities Act Rule 405, or provide a legal analysis in support of its belief that it should not be considered a shell.

Under Rule 405, in order to meet the definition of a “shell company” the Issuer must have

  1. No or nominal assets; or
  2. Assets consisting solely of cash or cash equivalents; and
  3. No or nominal operations.

What Happens if an Issuer Declares Shell Status in an S-1?

For those Issuers which truly are “shells” (such as those with no business model other than to find an operating company to merge into or acquire), declaring shell company status will require the Issuer to revise its prospectus, including the cover page and prospectus summary, to disclose that the Issuer is a shell company.

A shell company Issuer will also need to disclose in the Risk Factors section, the consequences of “shell status” including restrictions on the Issuer’s ability to use registration statements on Form S-8, the limitations on the ability of its shareholders to use Rule 144 and potential illiquidity of its securities.

Declaring shell status in an S-1 when the company is actually a shell does not prevent the S-1 from being declared Effective.  However, according to the “Evergreen Rule” it does have lasting implications (forever) for shareholders looking to deposit and clear restricted stock in the future under Rule 144.

Is a Startup Company Considered a Shell Company Under Rule 144?

No, a start-up company was specifically not intended to be classified as a shell company under Rule 144, and if the S-1 is documented properly, a startup will not need to declare itself a “shell company.”

According to Footnote 172 to SEC Release No. 33-8869 (which was the release that accompanied the final amendments to Rule 144), the amendments to Rule 144 were not intended to capture a “start-up” company or a company with limited operating history that was in the early stages of development.

This footnote was intended to address the concerns of several comments to Release No. 3-8869 that defined a shell company, and the primary concern was that the definition of a shell company was too broad as it would capture and include almost every business in its early stages of development, and specifically those in the start-up phase of operations.

Footnote 172 addressed these concerns in providing that a “start-up company” is excluded from the definition of a shell company since “such a company doesn’t not meet the condition of having no or nominal operations”.

Securities Lawyer for Start Up Companies Going Public via S-1 Registration Statement

Startup entrepreneurs seeking an IPO on the OTC Bulletin Board (“OTCBB”) or the OTC Markets OTCQB can contact securities attorney Matt Stout for a free consultation at (410) 429-7076 or mstout@otclawyers.com.


Shell Status for Start Ups and Development Stage Companies Under SEC Rule 144

Revenue and Major Assets Are Not Mandatory to Go Public or Avoid Shell Status

Many entrepreneurs interested in “going public” express concern when learning about the PCAOB audit required before they can file an S-1 Registration Statement.   This concern is usually caused by their belief that their company must be revenue producing and have huge assets before they are eligible to be audited.

Not only is this untrue, but many public companies in the OTC Markets have never produced any revenue, and still avoid being classified as a shell under Rule 144.  Others may have assets which by NYSE standards would seem paltry, but when compared with their peers on the OTC Markets, are normal.

Simply put, when helping to prepare an S-1 Registration Statement to take a company public, an auditor’s job is to audit whatever actually happened, and if the company has earned no revenue, that is of no impediment to going public and it does not automatically make the company a shell.   If the assets consist only of a provisional patent, and a laptop, full disclosure can and should be made without worry, and without exaggeration.

Rule 144:  Start Ups and Development Stage Companies With No Revenue

The majority of microcap public companies are not household names with millions in assets or revenue.  Some of these spend millions doing research and development (“R&D”) of their technology or products, only to falter and switch business models when a “pivot” is necessary to survive.

Others are start ups which involve one entrepreneur with an idea.  He or she is the sole officer and director, who is funding the company’s meager budget out of pocket.  This funding might cover the company’s administrative costs of securities compliance and accounting, leaving little left over for marketing the business.  Perhaps a provisional patent was filed and a web site is created.

Under Rule 144, these companies are still not “shells.”   That is what a start up is supposed to look like, and entrepreneurs seeking to go public should not try to make their companies look bigger than they really are or to wait forever before filing their S-1 Registration Statement.

It is worth revisiting the definition of “shell status” under SEC Rule 144 in order to understand why a pre-revenue company is not necessarily a shell.

Definition of Shell Status Under Rule 144

Under Rule 144, a microcap public company does not meet the definition of a “shell company” if it has more than

  1. Nominal operations;
  2. Assets consisting solely of cash and cash equivalents; or
  3. Assets consisting of any amount of cash and cash equivalents and nominal other assets.

As noted, “revenue” is not shown within the definition.  Operations can be demonstrated in many ways that do not involve sales, revenue or profitability.  Start ups and development stage companies are generally focused on refining their business plan, paying consultants and advisors, protecting intellectual property, staying in compliance with SEC or OTCMarkets filing requirements and building a corporate organization.

Likewise, assets can be shown through leases, intellectual property like patents or trademarks, software, web sites, contracts, agreements, and equipment.

Transparency is the Key to Compliance

When determining shell status under Rule 144, operations are compared with other OTC Markets companies that are in the same boat….not with NASDAQ or NYSE multinationals with revenue in the Billions.

For this reason, start ups should not hesitate to go public if doing so will help achieve the company’s goals.  The key is to simply present the company’s financials as they actually are, and to let the auditors do their job.  In other words, full disclosure means to “tell it like it is.”  That is not glamorous, but it will keep the company out of trouble.

The good news is that Rule 144 was never meant to exclude start ups or development stage companies, which are specifically carved out of the shell status definition.   With that in mind, management should always strive for transparency in their S-1 Registration Statements, SEC Reports, OTC Markets filings, and news releases, even if competitors are doing the opposite.